Between 2010 and 2015, the rail-intermodal industry enjoyed double-digit revenue expansion, with noteworthy help from truck-to-rail conversions on shorter-haul freight moving less than 1,000 miles. Meaningful Class I infrastructure investment, shippers’ rising focus on slashing supply chain costs, and concerns over capacity constraints in trucking all contributed. Over the past year, however, cheap diesel prices and more readily available truckload capacity linked to a pullback in shipment demand have spoiled the fun and are hampering intermodal’s value proposition relative to trucking.

That said, investors have reason to be optimistic about intermodal’s prospects, especially considering that competing truckload carriers will continue to grapple with capacity-growth headwinds linked to new regulatory restrictions and the constrained driver pool. Said another way, intermodal's value as an alternative transportation option won't disappear—we think the industry can generate mid-single-digit growth over the long run.

This is good news for the major intermodal marketing companies and Class I railroads, and our expectations for intermodal demand improvement over the next few years are reflected in our current fair value estimates. For the rails, intermodal activity has outpaced carload growth for most other goods, and we believe it will be a core volume driver going forward. Following a deep dive into rail industry trends we’ve modestly increase our volume growth assumptions for intermodal and certain industrial commodities for the Class I rails, as well as our long-run earnings growth rate, and increased our fair value estimates 1%-11%. From a valuation perspective, Union Pacific is our favorite rail benefiting from intermodal market growth, combining our view of its intermodal returns and a few free cash flow metrics that look attractive relative to other rails. On the other hand, market-implied assumptions for the IMCs have recently become overly optimistic.

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